Managerial Economics

Chapter 1: Introduction
Chapter 5
Pricing under various markets
Syllabus Structure
Managerial
Economics
Chapter 3
Production Function
Supply Analysis
Chapter 1
Introduction. The nature
& scope of managerial
economic decision making
Chapter 6
Pricing strategies and
Methods
Chapter 9
Business and Government.
Chapter 8
Capital budgeting
Chapter 2
Demand analysis
and estimation
Chapter 4

Cost of Production
Cost Analysis
Chapter 7
Profit Policy
Introduction
You have Rs. 500 what will you do?

Make choices Dilemma (individual, society &
country)
Use resources to satisfy wants but all wants cant be
satisfied
Why?
Two fundamental facts:
Human being have unlimited wants;
Means of satisfying these wants are relatively scarce
from the subject matter of economics

Economics
Economics is the branch of Knowledge
that deals with how the scarce resources
can be used to produce valuable goods
and services and distribute them
efficiently among different classes of
people in the society.


What is Managerial Economics?
Douglas - Managerial economics is .. the
application of economic principles and
methodologies to the decision-making process
within the firm or organization.
Pappas & Hirschey - Managerial economics
applies economic theory and methods to business
and administrative decision-making.
Salvatore - Managerial economics refers to the
application of economic theory and the tools of
analysis of decision science to examine how an
organisation can achieve its objectives most
effectively.

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6
What is Managerial Economics?
Howard Davies and Pun-Lee Lam -
It is the application of economic analysis
to business problems; it has its origin in
theoretical microeconomics.
Economics is the study of the
making, buying, and selling of goods
or services.

MANAGERIAL ECONOMICS

Economicscontributestoagreatdealtowardsthe
performanceofmanagerialdutiesandresponsibilities.
Like:BiologyMedicalprofession
Physics-Engineering
Economicscontributestomanagerialprofession.
Managerswithworkingknowledgeofeconomicscan
performtheirfunctionsmoreefficientlythanthose
withoutit.
Theemphasishereisonthemaximizationofthe
objectiveandlimitednessoftheresources.Thetaskof
managementistooptimizetheuseofresources.
Nature
Fundamental Academic Subject
Economic rationale of business administration
Allocation of resources
Theory of firm
Market condition
Profits and Pricing
Basis of Decision Making
Pragmatic Approach
Help of Quantitative Techniques
Socio-Cultural Aspects
Scope of Managerial Economics

Scope
Demand Analysis & Forecasting
Cost & Production Analysis
Pricing Decisions, Policies & Practices
Profit management
Capital Management
Analysis of Business Environment
Allied Disciplines
Subject Extensively used concepts of the subject
Economics Demand function, Cost function, revenue function
etc.
Operations research Model Building, Linear programming, queuing,
transportation, Optimization techniques etc
Mathematics Algebra, Calculus, exponential, vectors etc
Statistics Averages, Measures of dispersion, Correlation ,
regression, time series, interpolation, probability
etc.
Accountancy Provides information relating to costs, revenue,
receivables, payables, profits/losses etc.
Psychology To understand the behavior of individuals in
terms of attitudes, perception, behavioral
implications, motivations etc and its helps in study
the behavior of customers, supplier/seller, investor,
worker or an employee
Organizational Behavior Helps in understanding the group behavior in
organization environment.
Business issues are

Operational or internal
Environment or external
Microeconomics applied to Operational
issues
Operational issues are of internal nature-include
problems which arise within the business
organization and fall within the purview and
control of the management.-
Choice of business and nature of products to
produce, how much to produce (size of the firm),
choosing the factors combination (technology),
how to price, how to decide on new investments,
how to manage profits and capital, how to manage
inventory etc
Micro economic theories

Theory of Demand
Production theory (Theory of firm)
Pricing theory
Profit analysis and Management
Theory of Capital and investment decisions

Macro economic applied
Macro economics issues is generally pertain to factors
in the economic environment in which the business
operates-
Type of economic system,
General trends in production, employment, income, -
prices, savings and investments
Structure & trends of working of the financial
institutions
Magnitude of and trends in foreign trade
Govts economic policies
Social factors
Political environment-govt attitude towards business
Degree of openness of the economy
Basis of
Difference
Micro - Economics Macro-Economics
ORIGIN Individuals, Small groups Large level, Nation
OBJECTIVE Supply Profit Max
Demand - Utility
Employment, economic
growth, stable Price
DRIVING FORCES Price Mechanism Demand &
Supply
National Income Agg
demand & Supply
ASSUMPTIONS Rational behaviour of
Individuals
Agg O/P of economy & its
resources
EQUILIBRIUM
ANALYSIS
Partial Individual, Industry General No of variables,
Interdependence
TIME ELEMENT Static analysis, @ particular
time
Time lags, Rates of change,
value of variables
The role of managerial economics in managerial decision
making
Managerial decision problems
Product price and output
Make or buy
Production technique
Internet strategy
Advertising media and intensity
Investment and financing
Economic concepts
Theory of consumer behaviour
Theory of firm
Theory of market structures and
pricing

Decision making tools
Numerical analysis
Statistical analysis
Forecasting
Game theory
Optimisation
Managerial Economics
Use of economics concepts and
decision making tools to solve
managerial decision problems
Optimal solutions
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The Use of Economic Models
Positive Economics:-
Derives useful theories with testable propositions
about WHAT IS.
analyze systematically & explain economic
phenomenon as they actually happen
Normative Economics:-
Provides the basis for value judgments on
economic outcomes. WHAT SHOULD BE
concerned with Ideal Economic situation,
not with what actually happens
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What is the purpose of economic analysis?
Why do we want to apply economic analysis to business
problems?
For the academic economist: to understand, to
make predictions about firms behavior
The positive approach to theory: What is?
For the businessperson: to assist decision-
making, to provide decision-rules which can be
applied
The normative approach to theory: What should
be?
Optimization
Optimization means solving problems in which
one seeks to minimize or maximize areal
function by systematically
Economics relies so heavily on optimization that
some economists define their field as the study of
optimization under constraints or optimization
under scarcity.
Modern optimization theory overlaps with game
theory and the study of (economic) equilibrium, as
well as traditional optimization theory.
THE OPPORTUNITY COST CONCEPT
Opportunity costs are the costs of displaced
alternatives. The opportunity cost of a decision is
meant the sacrifice of alternatives required by the
decision.
If a scarce resource is put to particular use, other uses
of the resources must be given up. The net revenue
that could be produced in the next best use of the
resource is called the opportunity cost of the resource
for the use actually made.
Opportunity cost also called alternative cost is the
expected return from the next best use of the
resource(s) which are foregone due to scarcity of
resources.

Marginal Analysis
Marginal analysis is used to assist people in
allocating their scarce resources to maximize the
benefit of the output produced.
Simply getting the most value for the resources
used.
Marginal analysis: The analysis of the benefits
and costs of the marginal unit of a good or input.

(Marginal = the next unit)

Marginal Analysis
A technique widely used in business decision-
making and ties together much
of economic thought.

In any situation, people want to maximize net
benefits:
Net Benefits = Total Benefits - Total Costs
The Control Variable
To do marginal analysis, we can change a variable,
such as the:

quantity of a good you buy,
the quantity of output you produce, or
the quantity of an input you use.
This variable is called the control variable .
Marginal analysis focuses upon whether the
control variable should be increased by one more
unit or not.

Key Procedure for Using Marginal
Analysis
1. Identify the control variable (cv).
2. Determine what the increase in total
benefits would be if one more unit of the
control variable were added.
This is the marginal benefit of the added
unit.
3. Determine what the increase in total cost
would be if one more unit of the control
variable were added.
This is the marginal cost of the added unit.



Key Procedure for Using Marginal
Analysis
4. If the unit's marginal benefit exceeds (or
equals) its marginal cost, it should be added.

Remember to look only at the changes in total
benefits and total costs.

If a particular cost or benefit does not change,
IGNORE IT !


Why Does This Work?

Because:

Marginal Benefit = Increase in Total Benefits
per unit of control
variable
TR / Q
cv
=

MR

where cv = control variable
Why Does This Work?
Marginal Cost = Increase in Total Costs
per unit of control
variable

TC / Q
cv
=

MC



Why Does This Work?
So:
Change in Net Benefits =

Marginal Benefit - Marginal Cost

When marginal benefits exceed marginal cost, net
benefits go up.

So the marginal unit of the control variable should
be added.

Example: Should a firm produce
more ?
A firm's net benefit of being in business is PROFIT.
The following equation calculates profit:

PROFIT = TOTAL REVENUE - TOTAL COST


Example: Should a firm produce
more ?
Where:

TR = (P
output
X Q
output
)

n

TC = (P
input
i
X Q
input
i
)

i=1

Assume the firm's control variable is the
output it produces.
Problem:
International Widget is producing fifty widgets
at a total cost of $50,000 and is selling them for
$1,200 each for a total revenue of $60,000.

If it produces a fifty-first widget, its total
revenue will be $61,200 and its total cost will
be $51,500.

Should the firm produce the fifty-first widget?

Answer: NO
The fifty-first widget's marginal benefit is
$1,200

($61,200 - $60,000) / 1

This is the change in total revenue from
producing one additional widget and is called
marginal revenue.

Answer:
The firm's marginal cost is $1,500
($51,500 - $50,000) / 1
This is the change in total cost from producing
one additional widget.

This extra widget should NOT be produced
because it does not add to profit:
Answer:
Change in Net Revenue (Benefit) =

Marginal Revenue - Marginal Cost

- $300 = $1,200 - $1,500

Q
cv
Q
widgets
TR TR TC TC

50 60,000 50,000
1 1,200 1,500
51 61,200 51,500

MR = TR / Q
cv
= $1,200 / 1 = $1,200
MC = TC / Q
cv
= $1,500 / 1 = $1,500
A Question:
What is the minimum price consumers would
have to pay to get a 51st Widget produced?

Consumers would have to pay at least $1,500
for the extra widget to get the producer to
increase production.

Summary
Marginal analysis forms the basis of economic
reasoning.
To aid in decision-making, marginal analysis looks
at the effects of a small change in the control
variable.
Each small change produces some good (its
marginal benefit) and some bad (its marginal
cost).
As long as there is more "good" than "bad", the
control variable should be increased (since net
benefits will then be increased).



Economic Model
In economics, a model is a theoretical construct
that represents economic processes by a set of
variables and a set of logical and/or quantitative
relationships between them.
The economic models a simplified framework
designed to illustrate complex processes, often but
not always using mathematical techniques.

economic models functions
Simplification of and abstraction from observed data
Means of selection of data based on a paradigm of
econometric study
Simplification function is helpful in diluting the
complex economic processes. Complexity are due
to
Individual and co-operative decision processes
Resource limitation
Environmental and geographical constraints
Institutional and legal requirements
Purely random fluctuations
Selection is important because the nature of an
economic model will often determine what facts
will be looked at, and how they will be compiled.
Additionally use of economic models include:
Forecasting
Deciding economic policy
Planning & allocation
Management of business
In financial models
Types of Economic Models
Stochastic models: Random process Models (Based on
statistics & Hypothesis Formulation)
Non- Stochastic models: may be purely qualitative (for
example, models involved in some aspect of social
choice theory) or quantitative (involving rationalization of
financial variables, for example, specific forms of functional
relationships between variables).
Qualitative models: Although almost all economic models
involve some form of mathematical or quantitative analysis,
qualitative models are occasionally used. Like
qualitative scenario planning in which possible future events
are played out. Another example is non-numerical decision tree
analysis. Qualitative models often suffer from lack of precision.


Quantitative modeling: At a more practical level, quantitative
modeling is applied to many areas of economics and several
methodologies have evolved more or less independently of each
other.
Accounting model : is based on the premise that for
every credit there is a debit. More symbolically, an accounting model
expresses some principle of conservation in the form
algebraic sum of inflows = sinks sources
Aggregate Models: Macroeconomics needs to deal with aggregate
quantities such as output, the price level, the interest rate and so on.
However, for the most part, these models are computationally much
harder to deal with and harder to use as tools for qualitative analysis.
For this reason, macroeconomic models usually lump together
different variables into a single quantity such as output or price.
Moreover, quantitative relationships between these aggregate
variables are often parts of important macroeconomic theories
Types of Economic Models
In economic static mean the studies focus only on
particular period of time
It is similar to taking a photo when you press the
button for a shot then the photo is just at a
particular point of time.
In Dynamic we focus on the change of time and
how the equilibrium change with time.
It is the same as watching the movie you can see
how the image animate and movement.
Static and Dynamics.
Static and Dynamics.
In static economies, consumption patterns become
rigid, and marketing is typically nothing more
than a supply effort.

In a dynamic economy, consumption patterns
change rapidly. Marketing is constantly faced with
the challenge of detecting and providing for new
levels of consumption, and marketing efforts must
be matched with ever-changing market needs and
wants.

Thank You